As advisers get to grip with changes within the industry, they are being forced to scrutinise every aspect of their firm.
One important factor is ensuring that the trading structure of their business is suitable, both now and for the future, as this could make a huge difference to reputation, risk and liability levels.
But what structure is best: a sole trader or a limited company? A business set up as a sole trader is owned and run by one individual, the main difference being there is no legal distinction between the owner and the business.
Meanwhile, a limited company is owned by shareholders, and even if there is only one shareholder, the assets and liabilities of the business are separate legal entities.
Pros and cons
Both structures have their advantages and disadvantages, and what may be a perfect structure for one industry could be risky for the adviser world.
The most attractive feature of the sole trader model is complete control over the business: the owner is the business, so consultations are non-existent.
Although this may be an ideal setup for individuals and small businesses in other industries, Piers Meadows, partner at Meadows Fraser Solicitors, warns that the drawbacks could well outweigh the advantages if adopted by an advice firm.
“The advantage of being a sole trader is that there are fewer requirements in terms of accounting and reporting and more flexibility in how you structure your business,” Meadows said.
“However, if you are a sole trader, you have unlimited liability, so if you are sued for any reason, your exposure is unlimited. This of course, is a big drawback,” he warns.
Steve Billingham, of Steve Billingham Consulting, agrees. He claims that apart from the control and accounting aspects of the model, he cannot see many advantages to having a sole trader business:
“You have little protection, are solely responsible for the business debts and your personal assets can be seized. On top of that, it is harder to borrow money which could make expanding or growing the business difficult,” he says.
However, the limited company structure has its drawbacks. For example, higher costs and more administrative requirements could deem it an inefficient prospect for some firms.
Despite this, Billingham argues the structure will always be the right path to choose for an advice business:
“For me, the limited personal liability afforded by limited company status is worth the requirement to file accounts on time, a task which just requires a level of organisation and a decent accountant,” he says.
“The separate legal entity, being taken more seriously by suppliers and business clients, and the fact it is likely to be easier to borrow money (or for larger firms, to raise money through equity) in order to fund growth or acquisitions, makes limited company status the preferred choice.”
Looking to the future
For IFAs, two events in the future are certain: retirement and the RDR. With a mass exodus of advisers predicted before the 2012 RDR deadline, for some advisers, the two inevitabilities will come hand in hand.
With this in mind, Chris Kilner, compliance consultant at SimplyBiz, says the personal liability aspect of a limited company is particularly important:
“When sole traders decide to become de-authorised, they remain personally liable for the advice they have provided while they were authorised – even in retirement.
“However, for a limited company, it is the entity itself that is liable for the services it provides, and once the company has been de-authorised and subsequently wound up, creditors will no longer be able to claim against it or the assets of the firm’s directors,” he says.
Another potential problem for sole traders is the prospect of future retrospective legislation. Over the past ten years, the financial advice industry has been subjected to several reviews, including pension and endowment reviews. In many cases ‘inappropriate advice’ was identified, and Kilner says this should be a warning to IFAs:
“These reviews were based on the retrospective application of legislation to the advice that was provided originally. This generated large payments of compensation and proved costly for those IFAs who were sole traders that had left the industry.”
The third option
However, Meadows says there is a ‘third way’. With a traditional partnership, each individual is jointly liable for the business debts, and in the event of bankruptcy, personal assets could be seized.
A limited liability partnership (LLP) is a hybrid of the traditional partnership and limited companies: partners enjoy limited liability but they are taxed on the same basis as a traditional partnership.
Whichever path an adviser chooses, Jitendra Patel, consultant solicitor at Brethertons Solicitors, stresses the importance of seeking professional advice, particularly as advisers come under considerable scrutiny from the FSA:
“Anyone considering the options must work within the FSA framework. The type and level of business to be undertaken will be a factor in assessing risk generally, and in weighing up the advantages of limited liability.
“Individual circumstances will inevitably be different for all businesses, so professional advice from experienced lawyers and tax accountants should be sought from the outset,” he says.
